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Introduction

Riding the Wave: What the NASDAQ’s Record High Means for Investors

The NASDAQ Composite Index hit a record high last week, sparking excitement, scepticism, and everything in between.

For those already invested, this milestone is a celebration—a testament to the rewards of staying in the market. But if you're still on the sidelines, it might feel like a missed opportunity, with every headline serving as a reminder of what could have been.

Critics quickly pounce, calling the market overheated and warning of an impending correction. History, they say, repeats itself. And they’re not entirely wrong.

Take 19 November 2021, when the NASDAQ peaked at 16,507, only to nosedive by 35% through the end of 2022. That dramatic downturn left scars on portfolios and rattled even the most seasoned investors.

But here’s the twist: as of last Friday, the NASDAQ closed 20% higher than its 2021 peak. That means even those who bought at the top three years ago are now sitting on gains.

What does this tell us? Markets have the resilience to recover and reward patience. The sceptics, however, continue to sound alarms, claiming today’s record highs are inflated by overconfidence and unsustainable optimism.

So, what should investors do? Digging into history, understanding market cycles, and recognizing opportunities within the noise can provide clarity. Whether you see the current market as a reason to celebrate or to be cautious, one thing remains certain: investing isn’t about timing the market but about time in the market.

1. What Drives Stock Prices? A Practical Framework for Investors

Ever wondered why stock prices rise or fall? And more importantly, how to tell if those movements are justified?

At its core, a stock price can be broken down into 2 key components:

• free cash flow (FCF) per share and

• price-to-FCF (P/FCF) ratio.

The formula is simple:

Share Price = FCF per Share × P/FCF Ratio

This equation highlights an important principle: any change in either FCF per share or the P/FCF ratio directly impacts the stock price. However, the driving forces behind these components are quite different.

1.1 The Power of FCF per Share: Management’s Influence

FCF per share is a reflection of management’s ability to grow revenue, control costs, and generate cash. For instance, Microsoft (NASDAQ: MSFT) reported a stellar free cash flow of $74.1 billion in FY2024, a nearly 25% year-on-year increase, highlighting exceptional operational efficiency.

When management consistently increases FCF per share, stock prices tend to rise proportionally. If the P/FCF ratio remains constant, growth in FCF per share is a reliable indicator of long-term value creation.

1.2 The Volatility of the P/FCF Ratio: Market Sentiment’s Role

Unlike FCF per share, the P/FCF ratio is influenced by market sentiment, which can swing dramatically based on economic conditions. In bullish markets, valuations often expand, with P/FCF multiples climbing to unsustainable highs. Conversely, bearish markets compress these multiples, regardless of the company’s performance.

Take the tech sector as an example: during the pandemic boom of 2021, many high-growth companies saw their P/FCF ratios soar, only to come crashing down as investor sentiment shifted in 2022. Gains driven by expanding P/FCF ratios are inherently unreliable, as they are subject to the whims of the market.

1.3 The Bottom Line: Focus on What Matters

Investors should prioritize companies that demonstrate consistent growth in FCF per share—an indicator of strong management and sustainable operations. While P/FCF ratios provide short-term gains during market upswings, they are not a dependable source of value.

By understanding this framework, you can make better-informed decisions and focus on stocks that deliver tangible growth, not just fleeting hype. As Warren Buffett famously said, “In the short run, the market is a voting machine, but in the long run, it’s a weighing machine.” Let FCF per share guide your investment strategy.

2. Are the Stock Price Gains Justified? Let’s Put It to the Test

When stock prices soar, it’s natural to wonder if the gains are truly warranted. How do we separate sustainable growth from market hype?

Enter the Magnificent 7: Alphabet (NASDAQ: GOOGL), Amazon (NASDAQ: AMZN), Apple (NASDAQ: AAPL), Meta Platforms (NASDAQ: META), Microsoft (NASDAQ: MSFT), NVIDIA (NASDAQ: NVDA), and Tesla (NASDAQ: TSLA).

2.1 A Dominant Force in the Market

By September 2024, these 7 tech giants collectively accounted for over 53% of the NASDAQ Composite Index, cementing their influence on the broader market. Their performance since the last market peak in November 2021 offers valuable insight into whether stock price gains are justified.

2.2 Impressive Returns That Outpace the Market

On average, the Magnificent 7 stocks have delivered a remarkable 71% gain since the 2021 market peak. Leading the charge is NVIDIA, whose stock price skyrocketed by an astonishing 347%, driven by surging demand for AI-powered GPUs.

Excluding NVIDIA’s extraordinary performance, the remaining six stocks still posted an impressive 25% average return, outperforming the NASDAQ Composite Index, which rose 20% above its 2021 peak by late 2024.

2.3 What’s Driving These Gains?

The Magnificent 7’s growth isn’t just about market sentiment—it’s backed by tangible achievements. For example:

• Microsoft reported a 25% increase in free cash flow to $74.1 billion in FY2024.

• Apple’s revenue climbed to a record $394 billion in 2023, with strong demand for its services segment.

• Amazon experienced double-digit growth in its AWS cloud division, solidifying its position in a trillion-dollar market.

These gains highlight the importance of focusing on companies with strong fundamentals, innovative leadership, and exposure to secular growth trends like AI, cloud computing, and renewable energy.

2.4 The Takeaway for Investors

The Magnificent 7’s performance underscores the value of applying a disciplined framework to assess stock price gains. Look beyond the hype and analyze the factors driving growth—such as revenue, free cash flow, and market share.

While not every stock can deliver NVIDIA-like returns, understanding the drivers of success can help you uncover the next market leader in your investment journey.

3. Are the Stock Safe to Buy Today? Let’s Dive Deeper

It’s easy to get caught up in market movements, but are stocks safe to buy at today’s levels?

While a quick look at performance charts may offer insights, it doesn’t tell the whole story—especially when it comes to valuation.

Take Meta Platforms as an example. The stock currently trades at nearly 30 times its trailing free cash flow (FCF), a level that critics argue signals an overheated market. And they’re not entirely wrong.

3.1 The Risks of High Valuation

At stretched valuations, the bar is set high for future growth. If Meta fails to deliver on its growth potential, its price-to-FCF multiple could shrink, dragging its stock price down with it.

3.2 Why Time Is on Your Side

But here’s the flip side: Meta’s management has a track record of delivering results. If the company can grow its FCF per share by 60% over the next three years, the value created could lead to a significantly higher stock price, even with a lower multiple.

This highlights the power of long-term investing. Stock prices may fluctuate, but over time, companies that consistently grow their FCF per share reward patient investors.

3.3 What Should You Do?

Instead of focusing solely on current valuations, ask yourself:

• Does the company have a strong competitive edge?

• Is management committed to delivering sustainable growth?

• Can the business capitalize on long-term trends?

For disciplined investors, time is the key ingredient. A long-term perspective helps you ride out market noise and focus on the fundamental drivers of stock performance. When management delivers on growth, chances are, you’ll come out ahead.

4. Get Ahead: Win Now, Grow Wealth

What’s the best move for investors in today’s uncertain market? The answer is simpler than you think.

4.1 Craft a Winning Watchlist

Start by creating a watchlist of high-quality stocks that you’d be excited to own. This list should feature companies with strong growth potential, resilient business models, and solid financials. Begin with a small investment in these stocks. If prices drop, view it as an opportunity to buy more shares at a better value.

4.2 Keep Cash in Reserve

Already have a portfolio? Keep a portion—say 10-20% of your holdings—in cash. Why?

• If markets rise, you’re already invested and can enjoy the gains.

• If markets dip, that cash reserve becomes a powerful tool to seize discounts on stocks you believe in.

4.3 Focus on Your Own Goals

The most important lesson? Invest for yourself. Success isn’t about keeping up with market trends or following others—it’s about achieving your personal financial goals.

Statistics show that long-term investors tend to outperform market timers. For instance, the S&P 500 has delivered an average annual return of 10.2% over the past 30 years, rewarding those who stayed the course through market highs and lows.

By maintaining a watchlist, staying flexible with cash, and prioritizing your objectives, you’ll set yourself up to win—no matter which way the market moves

Happy New Year and Happy Investing!!